Tighter new conditions on interest-only mortgages may make switching harder

Saturday 3 March 2012

Borrowers with interest-only mortgages could find it difficult to move home or switch their loan following a crackdown by some of the country's biggest lenders.

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NAOMI CAINE

Santander, Barclays and Lloyds Banking Group, which includes Lloyds TSB and Bank of Scotland, have all recently tightened up the rules for interest-only loans. Santander, for example, now demands a 50% deposit if you want to take out an interest-only deal. If you choose a repayment mortgage, you can borrow up to 90% of the property's value.

Lloyds Banking Group has also imposed stricter criteria on interest-only loans. The bank no longer considers cash savings, including Isas, an acceptable repayment plan for an interest-only mortgage, even if you have tens of thousands of pounds stashed away. Investment funds, such as stocks and shares Isas, are on the approved list. However, borrowers must have at least £50,000 in the savings plan and can only borrow up to 80% of the total value of the investment. So, if you have £100,000 in an equity Isa, you could borrow up to £80,000 to buy a property. The amount invested in a pension must be at least £1 million, which rules out an awful lot of borrowers.Lloyds ignores any future contributions to your pension or Isa in its calculations. The bank assumes investments will not grow over the term of the mortgage. In fact, it assumes the Isa will be worth 20% less than its current value at maturity. Woolwich, which is owned by Barclays, will not even accept a pension as a suitable repayment plan. It also discounts future Isa contributions and assumes a nil growth rate on the investment. Ray Boulger, of mortgage broker John Charcol, says: "The borrowers likely to be most dis-advantaged by these new rules are those with an existing interest-only mortgage who want to move or remortgage, particularly older borrowers in their 50s or even 60s."Many who have perfectly sensible repayment strategies will find they can't meet the new criteria and the nearer they are to their planned retirement age, the more unlikely they will be able to afford to switch to a repayment mortgage, or indeed be able to meet the lender's affordability requirements for a relatively short-term mortgage."Lenders are accused of hypocrisy. David Carmichael, director of Glasgow mortgage broker Taylor Carmichael Financial Services, says: "It seems quite remarkable these investment contracts can be marketed and sold through branch networks to the consumer with growth rate projections and aspirations higher than most deposit accounts, and yet the same customer is asked to assume the product will not grow £1 in value when it comes to repaying a mortgage."The big attraction of interest-only mortgages is the lower monthly payments. For example, if you borrowed £100,000 over 25 years at 4% on an interest-only deal, you would pay £333 a month. A repayment mortgage would cost £528 a month. However, interest-only mortgages are not cheaper in the long run because you do not pay back any of the capital debt as you go along. In other words, the lender charges interest on the entire loan for the entire term. If we use the same example, we can see the monthly payments of £333 on the interest-only mortgage would bring the total interest payments to £99,900 over 25 years.The borrower would then have to pay back the original £100,000, so the total mortgage cost is £199,900. But the total cost of the repayment mortgage at £528 a month for 25 years, is £158,400 – almost £50,000 less. Borrowers with interest-only loans have always been required to set up a savings plan to run alongside the mortgage and eventually repay the debt. However, many people historically have banked on a rise in the value of the property to clear the loan. Both are risky strategies because there are no guarantees – and you could end up selling your home to pay off the bank or building society. A repayment mortgage is safer because you pay off capital and interest each month, so you owe nothing at the end of the term and you own your home outright.Lenders have previously been happy to grant interest-only mortgages, with few if any questions.However, the changes coincide with a mortgage review by the Financial Services Authority, which is concerned many people with interest-only loans will be unable to pay their capital debt.Mr Carmichael says: "Lenders are under severe pressure to lend more responsibly, but this has manifested itself in some genuinely outrageous policy changes. "Until lenders find the 'middle ground' for interest-only mortgages there is a genuine risk the borrowers they are trying to protect will in many cases be forced into new financial hardship."

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Tighter new conditions on interest-only mortgages may make switching harder

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